The Consumer Price Index (CPI) is used by governments to measure inflation and price levels in their economies. Each government uses a different basket of goods and services to calculate its national CPI, which is compared to a base year. Central banks use the national CPI to measure inflation and set inflation targets.
The Consumer Price Index (CPI) is a measure that governments use to estimate inflation and price levels in their economies. Governments do this by establishing a collection of goods whose prices they will monitor and then produce a number representing how the cost of living has risen or fallen compared to previous years. Central banks can use their national CPI to judge inflationary trends in the economy.
Each government uses a different collection of goods and services, also known as a basket of consumer goods and services, from which to calculate its national CPI. This basket should offer a picture of the products each citizen uses throughout their life, such as food and housing, so the specific items often vary from country to country. As the items that consumers regularly buy change with changes in the market, governments adjust both the specific items in the basket of goods and the weight each price has in the index calculation to ensure that the CPI continues to accurately reflect the cost of living.
Governments calculate the national CPI in relation to a base year. This is usually the year the government established a basket of goods and started tracking their prices. For each subsequent measurement period, the total of prices in that commodity basket are recalculated and compared with the base year to produce a new value. The new CPI is determined by taking the percentage change between the base year and the new measurement period, multiplying it by 100, then adding this number to 100. This means that if the price of the basket of goods in a subsequent measurement period were 10% higher than the base year, so the CPI for that period would be 110.
Inflation, which is the degradation of a currency’s value resulting in higher prices, is a concern of every central bank. A certain amount of inflation is healthy in times of economic growth, but too much inflation can hurt an economy as it slips into a recession or depression. Central banks issue what’s called an inflation target each year: a percentage by which they expect overall prices in an economy to rise. The primary purpose of the national CPI is for central banks to measure inflation each year and see whether the inflation in their nation’s economy has met, fallen, or exceeded the inflation target that they have respectively issued. Banks do this by calculating the percentage change between the current year’s CPI and the year before.
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